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“I suspect that this most sudden and even violent lurch higher in interest rates is going to test financial structures that came into being during the period of very low nominal interest rates.”
– Jim Grant
Those financial structures are being tested. On Friday, financials were down 1.8%, while regional banks were down over 2% and close to their early 2023 banking crisis lows. The great frustration about this selloff is that the market is moving so slowly. Drip, drip, drip. The regional banks broke through their range and moved 20% lower. The microcaps have broken their range and are dripping lower. Microcaps, as judged by the IWC ETF, look like they will probably go down 20% from their most recent range low and are now halfway there. The latest to break down through their support is the small-cap stocks. They have just broken their range. Lower by 20%, I would say. The problem is the drip, drip, drip. It makes sense, though. While rates are dramatically higher, which should send stocks lower, the government is shoving money into the system in immense numbers. Trillions. Measures of GDP. It makes no sense, but it keeps the market from plunging. 4000 is the new magnet for the S&P 500.
The S&P 500 is down 10% since the last Fed rate hike in July and down 9% since our volatility signal went off in early September. The market is getting oversold and due for a bounce. 4000 is a huge support level. Water torture with stocks in negative gamma. That means there will be dips but also rips higher, which will scare some into chasing, followed by another move lower. Negative gamma has us inclined to watch for a reflexive bounce, which could get legs into the end of the year. It’s pretty tricky stuff here. Monday could be very interesting.
I see stock after stock and index after index repeating the same pattern. They all went higher after Covid and are now sliding back down to their price just before Covid hit. Coincidence? The post-Covid era was just a sugar high full of government stimulus, and that stimulus marches on. The good news? Corporations have had two years to increase earnings and buy back stock. That means their valuations are cheaper and thus more valuable to us at those same prices.
The hard part of the drip, drip, drip is that it makes it harder to hedge. Hedging has a time value that erodes with time. It basically costs you money the longer you hold it. It is making this environment very painful for some.
It is hard to stay on the sidelines, so we nibble. I still think we see some sort of tradeable low for bonds, but it is just drip, drip, drip. Year-end sentiment could easily take over in this negative gamma environment. Remember, it works both ways. Volatility up and down. Not just down. They could just as easily rip the market higher on little to no volume. We try to prepare for both.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
